January 12, 2015
The energy sector has opened itself up to value investors, after several years of being off limits due to sky-high multiples. Oil prices per barrel have collapsed from over $100 to less than $50 in six months, leading to large declines in stocks of oil majors, drillers and other oil service companies.
Extreme volatility is nothing new for oil, a commodity that sat at $11 in 1998, $147 in 2008 and everywhere else in between.
The global explanations posited for the the oil price collapse are as myriad as an intricate world: a slowing China, a spiteful Saudi Arabia, and feeble OPEC. Any one reason does disservice to the fact that a commodity price is determined by multivariate factors. There are too many moving parts in the world economy to render X as a reason without implicating Y. It may be appealing to come up with one macro nugget to explain the chart, but it’s an exercise in futility.
The only real reason why prices are low is that supply exceeds demand. Go any further into that riddle and you’ll accomplish precisely nothing.
As a result, macro attempts to trade around commodity prices based on some world “view” will be as dangerous as they always are. As usual, I’m resolutely agnostic to all these moving parts. Instead, I’m focused on the only thing knowable: the value of an asset relative to its cash flows.
By that measure, energy stocks have arrived in value territory. Regardless of whether China slows further, OPEC unravels, or the Fed blinks, or overleveraged oil companies go bust, these stocks are already priced for perdition.
This doesn’t mean that buying oil stocks here won’t lead to further losses over the next six months. It does mean that those who hold them 3-5 years will likely be very happy they did. We’re buying the VDE, the Vanguard Energy ETF, in all accounts where appropriate.
Today supply exceeds demand. Someday, sooner than most think, demand will exceed supply again. Why? No one knows.